Derivatives, Insurance Securities, and Other Investments

Question 1

Option buyer

Answer 1

Purchases the option for a premium price has the right/option to exercise the contract: can be the right to buy at the exercise/strike price or the right to sell. Considered the holder and the long

Question 2

Option writer

Answer 2

Receives a premium for option contract has sold the right. If the buyer exercises the right to buy shares, the writer must deliver them. If the buyer exercised the right to sell shares, the writer must purchase them. Considered the seller or the short.

Question 3

Option contracts

Answer 3

Cover 100 shares of stock per contract, can be American-style (where holder can exercise the contract between purchase and expiration date) or European style (can only be exercised immediately prior to expiration)
Give buyers the right to exercise, not an obligation to deliver

Question 4

Call option

Answer 4

Gives the buyer the right to call away or buy a specific number of shares at a specific price (exercise/strike) at any time up to and including a specific date (expiration).
Writer is expecting the price will remain below the exercise price for the duration of the contract and earn the amount the buyer paid
Buyer hopes the price will rise- if it rises above the exercise price, then the buyer buys the shares at the exercise price and could potentially sell for a higher price

Question 5

Naked call

Answer 5

Call option where the writer does not own underlying stock, which carries unlimited risk

Question 6

Put option

Answer 6

Gives the buyer the option to sell or put away specific number of shares to the option writer at any time up to and including the exercise/strike price
Writer expects the price will increase or remain above the exercise/strike price, if not, then it will be left unexercised at maturity and the writer makes money on the premium
Buyer hopes the price will decline

Question 7

What company facilitates trading of call and put options?

Answer 7

Options Clearing Corporation (OCC)

Question 8

Theoretical Intermarket Margining System (TIMS) methodology

Answer 8

sophisticated system for measuring risk involved with portfolios containing options, futures, and options on future positions

Question 9

Futures contracts

Answer 9

Legal obligation to deliver or take delivery of commodities in the future

Question 10

Futures contract listing

Answer 10

Delivery date: date commodity is exchanged for cash.
Open: The price at which the first transaction for the day was made.
High and low: The highest and lowest prices during the day.
Settle: Shortened version of “settlement price” which is a representative price. For example, the average of the high and low prices during the “closing period” designated by the exchange in question.
Change: The difference between the current price and the previous day’s settlement price.
Lifetime high and low: The highest and lowest prices recorded during the lifetime of the contract.
Open interest: The number of outstanding contracts from the previous day.

Question 11

What differentiates trading in futures from trading in stocks/options?

Answer 11

There are no specialists on futures exchanges- floor brokers/traders execute orders; also clearinghouse acts as intermediary between sellers and buyers

Question 12

Guaranteed Investment Contracts (GICs)

Answer 12

large denomination debt instruments offered by insurance companies, guarantees specified rate of return over 1-5 years

Question 13

When is all income generated by annuities considered taxable income?

Answer 13

When annuity payments continue beyond the life expectancy noted on IRS Table V

Question 14

Promissory notes

Answer 14

Debt instruments where investor is lending money to a corporation for fixed interest

Question 15

American Depositary Receipts (ADRs)

Answer 15

Financial assets issued by US banks representing indirect ownership of a specific foreign firm held on deposit in a bank in the firm’s home country, subject to foreign currency risk, generally satisfies definition for 15% qualified dividend rate

Question 16

Private placements

Answer 16

securities that don’t need to be registered that are sold to a small amount of sophisticated/accredited investors

Question 17

What are advantages of holding gold company stocks, gold coins, bullion and certificates

Answer 17

Gold companies stock provides a current return in the form of annual dividends. Gold coins can be stored in bank safe deposit boxes. They are standardized in weight and purity and can be purchased anywhere. Commissions on gold certificates are lower than bullion or coins.

Question 18

Initial /performance margin

Answer 18

5-15% security deposit in the form of cash/cash equivalents or a bank line of credit to guarantee futures contract

Question 19

Maintenance margin

Answer 19

> /=65% of initial margin required account equity, otherwise if a margin call for a variation margin /additional deposit of cash is not made, then the investor’s position may be closed out

Question 20

What does the conversion factor of interest rate futures depend on?

Answer 20

Whether Treasury bond is callable, with a first call date of at least 15 years after Dec 1 OR is not callable, with a maturity of at least 15 years from December 1.
The conversion factor is the proportion of par the delivered Treasury bond would be selling on the first day of the delivery month if it had a yield to maturity of 8%

Question 21

Bob owns a variable annuity. The accrued gain for the year is 16% or $16,000. Is the gain tax-deferred?

Answer 21

This contract is owned by a natural person (Bob). Taxation is deferred.

Question 22

Do ADRs satisfy the definition of “qualified foreign corporations” to get the 15% qualified dividend rate?

Answer 22

Most (but not all) ADRs satisfy the IRS definition of a “qualified foreign corporation”. Most ADRs fit the Internal Revenue Code, but some ADRs do not meet the definition.

Question 23

Which of the following is a determinant of an option contract’s total price?

Answer 23

By definition a premium is comprised of time premium and intrinsic value.